Week Three: Adjusting the Accounts and Preparation of Financial Statement

Required reading: Chapter 3 Sections 3.1 – 3.8 (133-138)

Chapter 2: S. 2.1 – 2.3 (77-89).
PRE-WORKSHOP Chapter 3 Number
QUESTIONS
Questions 3.6, 3.8: 3.9
Brief Exercises BE3.1, BE3.3, BE3.6
Exercises E3.1, E3.2, E3.7, E3.9, E3.12
WORKSHOP Problems PSA3.7 (see below for question;
complete parts a & b)

Questions
3.6 Why might the financial information in a trial balance not be up to date and
complete?
The financial information in a trial balance may not be up-to-date because:
(1) some events are not journalised daily because it is unnecessary and inexpedient to
do so
(2) the expiration of some costs occurs with the reduction in an asset with the passage
of time
(3) some items may be unrecorded because the transaction data are not known.

3.8. Explain the differences between depreciation expense and accumulated

depreciation.
Depreciation expense is an expense account whose normal balance is a debt. This account
shows the cost that has expired during the current accounting period. Accumulated
depreciation is a contra asset account whose normal balance is a credit. The balance in
this account is the depreciation that has been recognised from the date of acquisition to
the reporting date.

3.9. An entity has recognised revenue for which the services have not been performed
but the cash has been received. Which of the following accounts are involved in the
adjusting entry:
(a) asset, (b) liability, (c) revenue or (d) expense? For the accounts selected, indicate
whether they would be debited or credited in the entry.
Liability and revenue. The revenue account is debited and liability account (Revenue
received in advance) is credited. This is the nature of the adjusting entry if the original
entry was to record the amount received as revenue.
Brief Exercises
BE3.1 Identify the impact of transactions on cash and retained earnings. (LO1)

Transactions that affect profits do not necessarily affect cash.

Required

Identify the effect, if any, that each of the following transactions would have upon cash and
retained earnings. The first transaction has been completed as an example.

Cash Retained earnings

$ $
(a) –400 0
(b) 0 –150
(c) 0 +5,000
(d) +1,200 0
(e) –8,000 0
(f) 0 –4,000
(g) 0 0

BE3.3 Prepare adjusting entry for depreciation. (LO4)

At the end of its first year, the trial balance of Shah Ltd shows equipment $50 000 and zero
balances in accumulated depreciation— equipment and depreciation expense. Depreciation
for the year is estimated to be $6000. Prepare the adjusting entry for depreciation at 30
June, post the adjustments to T accounts, and indicate the statement of financial position
presentation of the equipment at 30 June.
Shah Ltd

June 30 Depreciation expense — equipment 6 000

Accumulated depreciation — equipment 6 000
(Depreciation for the year)

Depreciation expense — equipment

30/6 Accumulated depreciation 6 000
 Accumulated depreciation — equipment
30/6 Depreciation expense 6 000
FINANCIALSTATEMENT PRESENTATION IS NET
Equipment 50 000
Less Accumulated depreciation (6 000)
$44 000

BE3.6 Identify the financial statement for selected accounts; identify post-closing trial
balance accounts. (LO6, 7)
The following selected accounts appear in the adjusted trial balance for Khanna Ltd.
Indicate the financial statement on which each balance would be reported, and identify the
accounts that would be included in a post-closing trial balance.
(a) Accumulated depreciation.
(b) Depreciation expense.
(c) Retained earnings.
(d) Dividends.
(e) Sales.
(f) Supplies.
(g) Accounts payable.
Khanna Ltd
Account Financial statement Post-closing
trial balance
(a) Accumulated depreciation Statement of financial position Yes
(b) Depreciation expense Statement of profit or loss No
(c) Retained earnings Statement of financial position (and Yes
statement of changes in equity)
(d) Dividends Statement of changes in equity No
(e) Sales Statement of profit or loss No

(f) Supplies Statement of financial position Yes

(g) Accounts payable Statement of financial position Yes

Exercises
E3.1 Determine cash-basis and accrual-basis revenue. (LO1)
In its first year of operations, Tang Pty Ltd generated $178 000 for services provided, $64
000 of which was on account and still outstanding at year-end. The remaining $114 000 was
received in cash from customers.
The company incurred operating expenses of $95 000. Of these expenses, $80 500 were paid
in cash; $14 500 was still on account at year-end. In addition, Tang Pty Ltd prepaid $16
500 for insurance coverage that would not commence until the second year of operations.
Required
(a) Calculate the first year’s profit under the cash basis of accounting, and calculate the
first year’s profit under the accrual basis of accounting.
(b) Which basis of accounting (cash or accrual) provides more useful information for
decision makers?

Tang Pty Ltd

(a)
Cash basis Accrual basis
$ $
Service revenue 114,000 178,000
- Operating expenses 80,500 95,000
- Insurance expense 16,500 -
Profit $17,000 $83,000

(b) Both accrual basis and cash basis provide useful information. However, it can be
argued that the accrual basis of accounting provides more useful information about
performance for decision makers because it recognises the impact of accounting
transactions or events on specific accounting periods. The cash basis of accounting
only recognises cash transactions. The accrual basis of accounting provides a more
comprehensive picture of the business activities in the records. For example, accrued
basis profit takes account of all revenues and expenses for a period whether or not cash
is received or paid (provided recognition criteria are met). It also takes account of
internal events, such as the consumption of supplies or the depreciation of plant assets.

However, cash basis accounting is also useful. For example, the statement of cash
flows shows how much cash is generated from ordinary operating activities (which will
invariably be greater or less than accrual basis profit).

E3.2 Identify accounting concepts, principles, criteria and constraints. (LO2)

These are the concepts, principles, criteria and constraints discussed in this and previous
chapters:
1. Accounting entity concept.
2. Accounting period concept.
3. Historical cost principle.
4. Expense recognition criteria.
5. Full disclosure principle.
6. Going concern assumption.
7. Faithful representation.
8. Monetary principle.
9. Income recognition criteria.
Required
Identify by number the accounting concept, principle or constraint that describes each
situation below. Do not use a number more than once.
_________ (a) Is the rationale for why plant assets are not reported at liquidation value.
(Do not use the historical cost principle.)
_________ (b) Indicates that personal and business record keeping should be separately
maintained.
_________ (c) Ensures that all relevant financial information is reported.
_________ (d) Assumes that the dollar is the ‘measuring stick’ used to report on financial
performance.
_________ (e) Information is complete, neutral and free from material error.
_________ (f) Separates financial information into time periods for reporting purposes.
_________ (g) Requires recognition of expenses when the flow of economic benefits from
the entity is probable and able to be faith fully represented.
_________ (h) Indicates that market value changes subsequent to purchase are not
recorded in the accounts.

(a) 6. Going concern assumption.

(b) 1. Accounting entity concept.
(c) 5. Full disclosure principle.
(d) 8. Monetary principle.
(e) 7. Faithful representation.
(f) 2. Accounting period concept.
(g) 4. Expense recognition criteria.
(h) 3. Historical cost principle.

E3.7 Prepare adjusting entries. (LO4)

James Goodwin commenced a dental practice on 1 January 2022. During the first month of
operations the following transactions occurred.
(a) Performed services for patients and, at 31 January, $750 was earned for these
services but not yet billed to the patients.
(b) Electricity expense incurred and not paid or recorded prior to 31 January, $520.
(c) Purchased dental equipment on 1 January 2022 for $80 000, paying $20 000 in cash
and signing a $60 000 interest-bearing note payable. (Interest is payable on 31
December 2022.) The equipment depreciates at $400 per month and interest on the
note is $250 per month.
(d) Purchased a 1-year insurance policy on 1 January 2022 for $12 000.
(e) Purchased $1600 of dental supplies (recorded as an asset). On 31 January, $350
worth of supplies was still on hand.
Required
Prepare the adjusting entries on 31 January 2022. Use these account names: Accumulated
depreciation—dental equipment, Depreciation expense, Service revenue, Accounts
receivable, Interest expense, Insurance expense, Salaries expense, Interest payable, Prepaid
insurance and Salaries payable.

James Goodwin Dental Practice

General journal
$ $
Date Account name(narration) Debit Credit
2022
a Jan 31 Accounts receivable 750
Service revenue 750
(Service performed January)
b 31 Electricity expense 520
 Electricity payable 520
(Accrued electricity)
c 31 Depreciation expense 400
Accumulated dep’n — dental equipment 400
(Depreciation for the month)
31 Interest expense 250
Interest payable 250
(Accrued interest)
d 31 Insurance expense 1 000
Prepaid insurance 1 000
(January insurance exp. 12000/12)
e 31 Supplies expense 1 100
Supplies ($1600 – $500) 1 100
(Supplies used January)

E3.9 Prepare a correct statement of profit or loss. (LO1, 3, 4, 5)

The statement of profit or loss of Chilli Peppers Pty Ltd for the month of July 2023 shows a
profit of $2800 based on service revenue $11 000; wages expense $4600; supplies expense
$2400; and electricity expense $1200. In reviewing the statement, you discover the
following.
1. The benefit consumed for prepaid insurance during July was not recorded — $600.
2. Supplies expense includes $800 of supplies that are still on hand at 31 July.
3. Depreciation on equipment of $300 was omitted.
4. Accrued but unpaid wages at 31 July of $600 were not included.
5. Services totalling $1600 were performed but not invoiced.
Required
Prepare a correct statement of profit or loss for the month of July 2023.

Chilli Peppers Pty Ltd

Statement of profit or loss
for the month ended 31 July 2023

REVENUES: $ $
SERVICE REVENUE ($11000 + $1600) 12 600
EXPENSES:
WAGES EXPENSE ($4600 + $600) 5 200
SUPPLIES EXPENSE ($2400 – $800) 1 600
ELECTRICITY EXPENSE 1 200
INSURANCE EXPENSE 600
DEPRECIATION EXPENSE 300
TOTAL EXPENSES 8 900
PROFIT $3 700
E3.12 Journalise basic transactions and adjusting entries. (LO4)
Selected accounts of Snowmass Ltd are shown here.

Required
After analysing the accounts, journalise (a) the July transactions and (b) the adjusting
entries that were made on 31 July. (Hint: July transactions were for cash.)

Snowmass Ltd
General journal

Date Account name (narration) $ $

Debit Credit
(a) July 10 Supplies 200
Cash 200

14 Cash 3 000
Service revenue 3 000

15 Salaries expense 1 200

Cash 1 200

20 Cash 700
Service revenue received in advance 700

(b) July 31 Supplies expense 500

Supplies 500

31 Salaries expense 1 200

Salaries payable 1 200

31 Service revenue receivable 500

Service revenue 500

31 Service revenue received in advance 900

Service revenue 900
Workshop question
PSA3.7 Prepare adjusting entries, adjusted trial balance, and financial statements. (LO4, 5,
6)
Smart Rentals Ltd opened for business on 1 April 2023. Here is its trial balance before
adjustment on 30 June 2023 presented on
a worksheet.

In addition to those accounts listed on the trial balance, the chart of accounts for
Showroom Rentals Ltd also contains the following accounts: 123 Accumulated depreciation
—building, 131 Accumulated depreciation—furniture, 506 Depreciation expense, 512
Insurance expense, 515 Interest expense, and 530 Supplies expense.
Other data:
1. Insurance expires at the rate of $900 per month and is an annual premium
commencing 1 April 2023.
2. An inventory of supplies shows $7200 of unused supplies on 30 June.
3. Depreciation is $5400 on the building and $4500 on furniture (depreciation to 30
June 2023).
4. The mortgage interest rate is 6%. (The mortgage was taken out on 1 April.)
5. $9000 of the rent revenue received in advance pertains to June. The remainder
pertains to July.
6. Salaries of $1800 are unpaid at 30 June.
7. Using the information provided complete the above worksheet.
Required
(a) Journalise the adjusting entries on 30 June.
(b) Prepare a ledger using T accounts. Enter the trial balance amounts as opening
balances and post the adjusting entries.
(c) Prepare an adjusted trial balance on 30 June.
(d) Prepare the statement of profit or loss and a calculation of retained earnings for the
quarter ended 30 June 2023, and prepare the statement of financial position as at 30
June 2023.
(e) Identify which accounts should be closed on 30 June.
Smart Rentals Ltd
Worksheet as at 30 June 2023

(a)

Trial balance Adjustments Adjusted trial Statement of Statement of

balance. profit or loss financial position
No Account names Dr $ Cr $ Dr $ Cr $ Dr $ C $r Dr $ Cr $ Dr $ Cr $
.
10 Cash 15 000 15 000 15 000
0
11 Prepaid insurance 10 800 2 700 1 8 100 8 100
2
11 Supplies 11 400 4 200 2 7 200 7 200
3
12 Land 90 000 90 000 90 000
0
12 Building 420 000 420 000 420 000
2
12 Acc’d depn — building 5 400 3 5 400 5 400
3
13 Furniture 100 800 100 800 100 800
0
13 Acc’d Depn — 4 500 3 4 500 4 500
1 furniture
20 Accounts payable 28 200 28 200 28 200
0
21 Rent rev. rec’d in adv. 21 600 9 000 5 12 600 12 600
2
21 Salaries payable 1 800 6 1 800 1 800
4
21 Interest payable 3 150 4 3 150 3 150
5
22 Mortgage payable 210 000 210 000 210 000
0
30 Share capital 360 000 360 000 360 000
0
40 Rent revenue 55 200 9 000 5 64 200 64 200
0
50 Advertising expense 3 000 3 000 3 000
5
50 Depreciation expense 9 900 3 9 900 9 900
6
51 Electricity expense 6 000 6 000 6 000
0
51 Insurance expense 2 700 1 2 700 2 700
2
51 Interest expense 3150 4 3 150 3 150
5
52 Salaries expense 18 000 1 800 6 19 800 19 800
5
53 Supplies expense 4 200 2 4 200 4 200
0
$675 $675 000 $30 $30 $689 $689
000 750 750 850 850
Profit 15 450 15 450
$64 $64 $641 100 $641 100
200 200
(b)

Smart Rentals Ltd

General journal
Date Account name (narration) Post ref. Debit $ Credit $
2023
1 June 30 Insurance expense 512 2 700
Prepaid insurance 112 2 700
(To record expired insurance)

2 30 Supplies expense 530 4 200

Supplies 113 4 200
(To record supplies consumed)

3 30 Depreciation expense 506 9 900

Accumulated depreciation — building 123 5 400
Accumulated depreciation — furniture 131 4 500
(To record depreciation expense for 3 months)

4 30 Interest expense 512 3 150

Interest payable 215 3 150
(To record interest accrued ($210,000 x6%)x3/12)

5 30 Rent revenue received in advance 212 9 000

Rent revenue 400 9 000
(To record June rent)

6 30 Salaries expense 525 1 800

Salaries payable 214 1 800
(To record accrued salaries)

(c)
Smart Rentals Ltd General ledger
Cash 100
30/6 Balance 15 000

Prepaid insurance 112

30/6 Balance 10 800 30/6 Insurance expense 2 700
30/6 Closing balance 8 100
10 800 10 800
1/7 Opening balance 8 100

Supplies 113
30/6 Balance 11 400 30/6 Supplies expense 4 200
30/6 Closing balance 7 200
11 400 11 400
1/7 Opening balance 7 200

Land 120
30/6 Balance 90 000

Building 122
30/6 Balance 420 000

Accumulated depreciation — building 123

30/6 Depreciation expense 5 400

Furniture 130
30/6 Balance 100 800

Accumulated depreciation — furniture 131

30/6 Depreciation expense 4 500

Accounts payable 200

30/6 Balance 28 200
Rent revenue received in advance 212
30/6 Rent revenue 9 000 30/6 Balance 21 600
30/6 Closing balance 12 600
21 600 21 600
1/7 Opening balance 12 600
Salaries payable 214
30/6 Salaries expense 1 800

Interest payable 215

30/6 Interest expense 3 150

Mortgage payable 220

30/6 Balance 210 000
 Share capital 300
30/6 Balance 360 000

Rent revenue 400

30/6 Balance 55 200
30/6 Rent revenue in advance 9 000
64 200
Advertising expense 505
30/6 Balance 3 000
Depreciation expense 506
30/6 Accumulated depreciation 9 900
Electricity expense 510
30/6 Balance 6 000
512
Insurance expense
30/6 Prepaid insurance 2 700
515
Interest expense
30/6 Interest payable 3 150

525
Salaries expense
30/6 Balance 18 000
30/6 Salaries payable 1 800
19 800
Supplies expense 530
30/6 Supplies 4 200

(d)
Smart Rentals Ltd
Adjusted trial balance
as at 30 June 2023
No. Account names Debit $ Credit $
100 Cash 15 000
112 Prepaid insurance 8 100
113 Supplies 7 200
120 Land 90 000
122 Building 420 000
 123 Accumulated depreciation — building 5 400
130 Furniture 100 800
131 Accumulated depreciation — furniture 4 500
200 Accounts payable 28 200
212 Rent revenue received in advance 12 600
214 Salaries payable 1 800
215 Interest payable 3 150
220 Mortgage payable 210 000
300 Share capital 360 000
400 Rent revenue 64 200
505 Advertising expense 3 000
506 Depreciation expense 9 900
510 Electricity expense 6 000
512 Insurance expense 2 700
515 Interest expense 3 150
525 Salaries expense 19 800
530 Supplies 4 200
$689 850 $689 850

(e)

Smart Rentals Ltd

Statement of profit or loss
for the three months ended 30 June 2023
$ $
Revenues:
Rent revenue 64 200
Expenses:
Advertising expense 3 000
Depreciation expense 9 900
Electricity expense 6 000
Insurance expense 2 700
Interest expense 3 150
Salaries expense 19 800
Supplies expense 4 200
Total expenses 48 750
Profit $ 15 450

Smart Rentals Ltd

Calculation of retained earnings
for the three months ended 30 June 2023

Retained earnings, 1 April $ -

Add: Profit 15 450
Retained earnings, 30 June 2023 $15 450
 Smart Rentals Ltd
Statement of financial position
as at 30 June 2023
$ $
Assets
Current assets
Cash 15 000
Prepaid insurance 8 100
Supplies 7 200
Total current assets 30 300
Non-current assets
Land 90 000
Building 420 000
Less: Accumulated depreciation (5 400) 414 600
Furniture 100 800
Less: Accumulated depreciation (4 500) 96 300
Total Non-current assets 600 900
Total assets 631 200

Liabilities
Current liabilities
Accounts payable 28 200
Rent revenue received in advance 12 600
Salaries payable 1 800
Interest payable 3 150
Total current liabilities 45 750
Non-current liabilities
Mortgage payable 210 000
Total liabilities 255 750
Net assets $375 450
Equity
Share capital 360 000
Retained earnings 15 450
Total equity $375 450

(f) The following accounts would be closed: Rent revenue, Advertising expense,
Depreciation expense, Electricity expense, Insurance expense, Interest expense, Salaries
expense, Supplies expense.